Transporting: Russia’s Rent Addiction and Far East Infrastructure

Political excitement about infrastructure development in Russia’s Far East seems to exist in a parallel universe.

By Nicholas Trickett for The Diplomat

December 06, 2017

Far East development is an evergreen concern for Russia’s strategic outlook. In a piece for Bloomberg ahead of the APEC forum, President Vladimir Putin touted the development of Eastern Siberia and the Far East as a national priority for Russia in the 21st century. The “Pivot to Asia” is a serious matter of Russian policy, despite the lackluster results thus far. Moscow needs the Far East to be self-sufficient economically in order to reduce the considerable budget expenditures spent subsidizing and supporting the region.

Lack of physical access within and to the Far East is a substantial problem for economic growth. Russia’s targeted investment program for the region from 2017-2020 calls for 542.2 billion rubles ($9.1 billion), 215.6 billion of which are to come from the federal budget. But budgets are tight and figures for federal investments into infrastructure in the region don’t add up. A lack of budget resources and exorbitant construction costs threaten Moscow’s infrastructure projects as it becomes less clear that they’re fit to drive economic growth. Rhetoric is increasingly divorced from reality.

At the end of November, the Ministry of Transport (MinTrans) issued a statement that planned funding for 40 airport projects from 2014-2017 had fallen 66.3 percent short, reaching 24.8 billion rubles. Only 17 of the 40 projects were to be completed by the end of 2017 as a result of reduced financing from the Ministry of Far East Development to the Federal Air Transport Agency. Yuri Trutnev, deputy prime minister and presidential envoy to the Far Eastern Federal District, clarified that as of 2013, 106.1 billion rubles in state support for regional airport construction were set aside. Sixty-four billion rubles “fell through” because too many projects were poorly prepared and funds were shifted elsewhere. The TASS press release added that 70 percent of the Far East – a little less than a quarter of Russian territory – lacks access to an airport.

According to the Ministry of Far East Development, more than 800 kilometers of federal and regional roads are to be built or reconstructed by the end of 2020. Ignoring the fact that the total distance is inconsequential given the region’s size, the road program is likely overselling what’s possible given costs. A 27-kilometer bypass around Khabarovsk is expected to cost 42.8 billion rubles, nearly 1.6 billion rubles per kilometer. To put it in American terms: There’s no good reason less than a mile of road should cost over $27 million.

While an imperfect measure – costs from terrain and route vary widely and some projects are repair works for existing roads – similar costs per kilometer elsewhere would run Moscow around 1.2 trillion rubles on their roads program through 2020 in the region, more than double the entire targeted investments program for the same timeframe. The issue extends to all infrastructure development for federal and regional level projects.

Russian Railways (RZhD) is 100 percent state-owned and relies on state support because it’s often forced to offer significant discounts to sustain remote cities and towns. The company has laid out an investment program for more than 1.8 trillion rubles over the next three years. RZhD has consistently been behind the ball on the modernization of the Trans-Siberian (Transsib) and Baikal-Amur Mainline (BAM) railways, which would enable the region to more effectively capitalize on China’s transit trade as well as expand access to Russia’s Pacific ports. Expenditures were slated at 95.8 billion rubles total for both routes in 2017, the equivalent of two road bypasses around Khabarovsk.

The modernization of Transsib and BAM is estimated to cost 562 billion rubles in total. A combination of funding from the federal budget and the National Welfare Fund (NWF) were meant to cover 250 billion rubles, with the rest coming from the company’s coffers. The Ministry of Finance convinced the Kremlin to cease all direct budget support for the modernization plan and rely on the NWF, but the shift in resources left RZhD 38.5 billion rubles short.

State support for RZhD is declining structurally. The Ministry of Finance’s budget plan currently provides a total of 34.2 billion rubles to RZhD next year, dropping to 22.5 billion rubles annually for 2019-2020. Eventually, it will force the RZhD to raise tariffs, disproportionately hurting the Far East. Current construction plans call for 580 kilometers of new mainlines, signaling upgrades for 630 kilometers of track and 43 crossings, and the renovation of 90 railway stations.

Given how far money goes at the project level, it’s unclear if the project list is realistic. These building costs don’t factor in a proposed bridge to Sakhalin Island, which would redirect at least several hundred billion rubles away from spending needs elsewhere. Financial shortfalls point to an increasingly messy budget situation.

The Rents Are Too Damned High

Moscow wields the power of the purse as a means of negotiating its political and social contracts with the country’s many regions. Despite growing strains on financial resources, next year’s budget sees a 5 percent increase in subsidies given to regional governments. Money is needed to firm up support in an election year. Stagnant economic growth is fueling greater tensions over budget policy.

For the 2018 budget, the Ministry of Finance is planning to issue 645.1 billion rubles in subsidies to the regions. The Republic of Sakha (Yakutia) and Kamchatka region are the second and third biggest recipients of subsidies for next year at 43.94 billion and 39.36 billion rubles respectively. Subsidies account for about 28 percent of Sakha’s budget and 63 percent of the Kamchatka region’s budget. These subsidies largely go towards social services and programs meant to sustain populations living in remote regions facing high costs for consumer goods and price subsidies for things like heating.

More money is sorely needed. In Sakha, for example, the main Federal highway “Vilyui” has fallen into such disrepair that local residents are forced to use roads owned and tolled by regional oil companies. Other regional governments are fighting for more funding or to protect what they have.

Sakhalin Island has tried to keep its taxes on profits from the Sakhalin-2 oil project, its leading source of budget revenues. The previous revenue-sharing agreement had Sakhalin keeping 75 percent and giving the rest to Moscow. Moscow preferred to take 75 percent but settled on a compromise. Per legislation, Sakhalin is now obligated to hand over 50 percent of the corporate profits tax from Sakhalin-2 to the federal budget, which will then be given back to the Far East via federal mechanisms. The transfer amounts to 33.7 billion rubles next year, 17.7 billion rubles in 2019, 16.9 billion rubles in 2020.

The transfer achieves two things for Moscow: it federalizes funds that could otherwise have been dispensed to local elites for projects and favors and it frees up capital for larger projects. But the loss will be keenly felt. Sakhalin region’s budget revenues stood at 201 billion rubles in 2015 and will fall to around 80 billion rubles for 2019 and 2020. The region faces a serious budget crunch with Moscow raiding its coffers and shifting subsidies elsewhere.

This year’s budget for Primorye region — home to the port of Vladivostok — counted 95.6 billion rubles in revenues and 99.6 billion in expenditures. The 2018-2020 window does not offer any serious changes in terms of available financing for infrastructure. Costs associated with “territories of accelerated development” – investment zones with tax and administrative exemptions – will be spread out over multiple years and, notably, all major infrastructure initiatives are to be funded by the federal budget. Yet the federal budget only includes about 33 billion rubles earmarked for major projects in the Far East, some of which are social and not connected to infrastructure at all. These trends hold true for the Far East Federal District’s remaining regions.

This deluge of figures seems daunting because it is. Though expenditures can be added up, there are large gaps that federal money is somehow supposed to fill. What constitutes “federal money” is also obscured at times given the fact that three ministries – the Ministries of Finance, Transport, and Far East Development – all have separate funding mechanisms. By extension, RZhD and any state-owned firms linked to the ministries have investment programs that are implicitly federal, receive state support, and control tenders.

The institutional framework for Far East infrastructure planning maximizes the extent to which projects can be plundered by those in search of profits and favors while minimizing any one group’s ability to control policy. The state has to drive investments in the region. They simply aren’t economically logical without subsidies or state support. Lobbies in Moscow can exploit that structural dependency. Budgets and costs imposed by corruption don’t bode well for future projects, but the problem is greater than connectivity.

Really Existing Development

Infrastructure is certainly integral to developing the Far East’s economy. Improving access, lowering transport costs, and enabling the diversification of the region’s economy from natural resource extraction to value-added industries and services require infrastructure investment. However, broader economic issues will limit the value of the projects actually being built. Moscow touts positive economic indicators for the region, but they hide the scope of the challenge it faces.

The Ministry of Far East Development reports that regional growth has consistently outpaced national growth and is speeding up recently. Through September, fixed capital was up over 10 percent year-on-year, construction was up 11 percent year-on-year as of October, agriculture was up 5 percent, and manufacturing up 3 percent. The Far East attracts roughly 25 percent of all direct investment into Russia and there are reportedly 10 rubles of private investment for every 1 ruble of state investment into infrastructure. None of that holds up well under scrutiny.

Growth in construction and fixed capital is driven by the Power of Siberia pipeline and associated petrochemical projects. They will generate tax revenues but the business climate compromises attempts to build factory complexes and other supply chains around the petrochemical industry. Though manufacturing is up, Gazprom is largely sourcing pipeline and machinery orders from firms in St. Petersburg, Moscow, or European Russia. Gazprom is also forcing construction at a faster pace because of concerns about competitors on the Chinese market, with some noting that the threat of LNG supplies from the United States to China has added urgency to the project. Considerable volumes of Russian money brought back into the Russian Far East via offshores as “foreign” investment as well as state-directed “private” investment also skew these figures.

Though the Ministry of Far East Development points to the fact that wages are 20 percent higher on average than the rest of the country, the Far East suffers the worst wage arrears rates of anywhere in Russia. Possible wage increases for state employees will lead to layoffs because of tight budgets, pensions can’t be raised for similar reasons, and only Sakhalin’s budget was sustainable but is now being raided. On top of all this, costs are considerably higher for basic goods, eating up higher paychecks. Extreme distances raise consumer costs as does low population density and Russia’s rail freight market is a mess. Salaries are higher on paper, not in reality.

Alongside these issues, the administrative ploys to attract investment aren’t working. A damning late October report from the Russian Audit Chamber found that of 19 million hectares of land assigned to “territories of accelerated development,” less than 1 percent had actually been transferred out of the state’s hands. Not all has failed but investments that would sustain growth and create more tax revenues are rarely very forthcoming. Too much rests on federal money, federal initiatives, and federally owned companies.

The Far East will see some real growth as pipeline and petrochemical projects are completed. But Russia’s addiction to rents in a time of shrinking budgets kneecaps its ability to build infrastructure effectively. Costs are inflated and decision-making is centralized in Moscow to enrich those with access to tenders. That very centralization hides the institutional chaos playing out between the relevant bodies in charge of setting policy, a situation that’s the worst of both worlds.

The pronouncements of political leaders about the Far East’s infrastructure development seem to exist in a parallel universe. Even with systemic investment fitting the region’s needs, infrastructure is not a panacea. Until costs and the system of patronage and political control that inflates them are brought down, the Russian Far East will remain an expensive periphery.

Nicholas Trickett holds an M.A. in Eurasian studies through the European University at St. Petersburg with a focus on energy security and Russian foreign policy. He is a columnist and contributor for the Bear Market Brief, a blog and daily news brief on Russia’s politics and economy, and contributes to other outlets like Global Risk Insights, Oilprice, and Newsbase.